Global lending body International Monetary Fund on Friday asked countries to preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future.
In a blog post, IMF’s Deputy Managing Director Gita Gopinath and chief economist Pierre-Olivier Gourinchas wrote that although emerging market central banks have stockpiled dollar reserves in recent years, lessons learned from earlier crises suggest that these buffers are limited and need to be used prudently.
“Countries must preserve vital foreign reserves to deal with potentially worse outflows and turmoil in the future. Those that are able should reinstate swap lines with advanced-economy central banks,” the blog post read.
The US dollar has continued climbing and is currently at its highest level since 2000, having appreciated 22% against the yen, 13% against the Euro and 6% against emerging market currencies since the start of 2022.
Consequentially the Indian Rupee has also taken a hit, with the rupee closing at 82.19 against the US dollar on Friday. Depreciation of the domestic currency can be a worry for countries that have significant imports.
Source: IMF Blog
Making the fight against inflation ‘harder’
Retail inflation in India has continued its steep climb and has remained over the upper limit of the Reserve Bank of India’s tolerance band
of 6% since January 2022.
“For many countries fighting to bring down inflation, the weakening of their currencies relative to the dollar has made the fight harder. On average, the estimated pass-through of a 10% dollar appreciation into inflation is 1%,” the blog read.
“Such pressures are especially acute in emerging markets, reflecting their higher import dependency and greater share of dollar-invoiced imports compared with advanced economies.”
The writers note that amid rising interest rates worldwide, financial conditions have tightened considerably for many countries. “A stronger dollar only compounds these pressures, especially for some emerging market and many low-income countries that are already at a high risk of debt distress,” they wrote.
The hit on forex reserves
India’s forex reserves dropped by $4.854 billion to $532.664 billion as on September 30, according to the RBI. Data shows that the overall foreign reserves held by emerging markets and developing economies have fallen by more than 6% in the first seven months of this year.
The RBI in its bid to maintain a stable level for the local currency has been intervening in the market. The local unit dropped to a record low of 82.6825 at the start of this week, prompting the RBI to step in. The RBI intervened heavily on Monday and Tuesday, traders said, and there was likely some sporadic intervention on the other days.
Observing that the appropriate policy response to depreciation pressures requires a focus on the drivers of the exchange rate change and on signs of market disruptions, the IMF blog said that specifically, foreign exchange intervention should not substitute for warranted adjustment to macroeconomic policies.
“There is a role for intervening on a temporary basis when currency movements substantially raise financial stability risks and/or significantly disrupt the central bank’s ability to maintain price stability,” it said.
IMF in its blog said that countries with the ability to do so must reinstate swap lines with advanced-economy central banks. Countries with sound economic policies in need of addressing moderate vulnerabilities should proactively avail themselves of the IMF’s precautionary lines to meet future liquidity needs.
Countries with large foreign-currency debts should reduce foreign-exchange mismatches by using capital-flow management or macroprudential policies, in addition to debt management operations to smooth repayment profiles.
Gopinath and Gourinchas noted that in some cases temporary foreign exchange intervention may be appropriate. This can also help prevent adverse financial amplification if a large depreciation increases financial stability risks, such as corporate defaults, due to mismatches, they wrote.
“Finally, temporary intervention can also support monetary policy in the rare circumstances where a large exchange rate depreciation could de-anchor inflation expectations, and monetary policy alone cannot restore price stability,” they said.
(With inputs from agencies)